AFI has issued a one-year loan commitment of $2 million for an up-front fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FI requires a compensating balance of 5 percent as demand deposits. The FI's cost of funds is 6 percent, the interest rate on the loan is 10 percent, and reserve requirements on demand deposits are 8 percent. The customer is expected to draw down 80 percent of the commitment at the begin- ning of the year.

a. What is the expected return on the loan without taking future values into consideration?

b. What is the expected return using future values? That is, the net fee and interest income are evaluated at the end of the year when the loan is due.

c. How is the expected return in part

(b) affected if the reserve requirements on demand deposits are zero?

d. How is the expected return in part

(b) affected if compensating balances are paid a nominal interest rate of 5 percent?

e. What is the expected return using future values but with the compensat- ing balance placed in certificates of deposit that have an interest rate of 5.5 percent and no reserve requirements, rather than in demand deposits?

 LO.1